Has a pay rise quietly increased your tax bill?
Many employees and business owners have welcomed higher earnings over the past few years. However, for a growing number of taxpayers, a bigger salary does not always mean more money in their pocket. In fact, the opposite can sometimes feel true. So, has a pay rise quietly increased your tax bill without you realising?
The reason lies in a process known as fiscal drag.
What is fiscal drag?
Although tax rates have remained broadly unchanged, personal tax thresholds have been frozen for several years. Meanwhile, wages continue to rise across most sectors. Consequently, more people are paying tax at higher rates, even when pay has only kept pace with inflation.
As a result, someone who previously paid only the basic rate of Income Tax may now pay tax at 40%. Others may have drifted into the additional rate band altogether. The effect can be surprisingly expensive, particularly when combined with the loss of valuable tax allowances.
The hidden knock-on effects
Moving into a higher tax band can affect far more than your Income Tax bill. Indeed, it can reduce reliefs you may not even realise you rely on. For example, higher earners could face:
- a reduced Personal Savings Allowance
- a higher rate of Capital Gains Tax on certain assets
- exposure to the High Income Child Benefit Charge
- a tapered Personal Allowance for income above £100,000
Notably, that last point creates an effective marginal tax rate of 60% on part of your income. Therefore, small pay rises can sometimes cost more than they gain.
Business owners should look twice
Business owners should also remember that higher personal income may affect how they extract profits. Consequently, the balance between salary, dividends and pension contributions deserves regular review. Otherwise, last year’s plan may quietly become this year’s tax problem.
Ways to reduce your taxable income
Fortunately, several legitimate planning opportunities remain available. Pension contributions, for instance, are still one of the most effective tools. Similarly, Gift Aid donations can extend your basic rate tax band. In addition, business owners may benefit from:
- reviewing the timing of dividends or bonuses
- considering employer pension contributions
- using available allowances before the tax year ends
- planning ahead with a qualified adviser
You can also check current allowances and thresholds on the HMRC website at https://www.gov.uk/hmrc.
Why early planning matters
The key point is simple. Do not assume that a higher salary automatically leaves you better off after tax. A modest pay increase can sometimes trigger unexpected consequences. In some cases, these consequences outweigh much of the additional income earned.
So, has a pay rise quietly increased your tax bill this year? If your income has changed recently, now is an excellent time to review your position. Early planning can reduce your liability while keeping your reliefs and allowances intact.
Get in touch
If you would like us to review your personal tax position or explore ways to improve your tax efficiency, please contact us today. We will be delighted to help you spot opportunities, minimise your tax bill and stay fully compliant with HMRC’s rules. Get in touch now for a friendly, no-obligation conversation about your next steps.
